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Stay The Course

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Mutual fund investors in India have had a roller-coaster ride. Little wonder then that despite having the potential to fit every investor's portfolio, mutual funds have failed to become the first investment choice. While it cannot be denied that investors' participation in mutual funds has been increasing over the years, issues like mismatch between expectations and reality, mis-selling, lack of understanding and wrong positioning of products have hampered the growth of the industry time and again. Besides, wrong investment strategies have added to investors' woes.

Here is how investor portfolios get affected when they follow wrong strategies, and how they can be rectified:

Abandoning equity funds during downturn
The first instinct of investors who invest in equity funds without a defined time horizon is to abandon them during a market downturn. A similar reaction is seen in investors who invest through a systematic investment plan (SIP) without any time commitment. While they happily invest in a rising market, they develop cold feet when the markets are actually presenting great long-term investment opportunities. Clearly, their fetish for catching the market bottom often makes them wary of taking the plunge. On the other hand, someone who invests with a long-term commitment has time on his side and hence is better prepared to handle these situations. 

Remember, short-term adverse movements in the market do not take away the ability of equity to outperform other asset classes in the long run. By continuing to invest during turbulent times, one can benefit a great deal when the market rebounds.
 
Relying too much on past performance
Investors often rely on short-term performance while investing in equity funds. This strategy takes them beyond their risk-taking capacity because investing in top-performing funds, when mid-cap stocks are doing well, would result in a significant amount getting allocated to mid-cap funds. Although mid-cap funds have the potential to do well, it is important to have a restricted exposure to them to maintain the risk-reward balance in the portfolio. No doubt, past performance is an important aspect in the decision-making process, but relying too much on it can be disastrous.

Too many schemes in portfolio
Many investors believe that the best way to diversify a mutual fund portfolio is to have a large number of funds. As a result, their portfolios suffer from over-diversification. Moreover, having too many overlapping funds makes portfolio-tracking quite complicated. In fact, a few carefully selected funds can not only provide a higher level of diversification but also improve portfolio returns.

While there is nothing like an optimal number of funds that one needs to own to have a sufficiently diverse portfolio, factors like size of the portfolio and asset allocation can play a key role in deciding that number.

Investing just before dividend payout
It is a common belief among a set of investors that investing in an equity fund just before dividend payment is a good strategy. The truth is that they receive a part of their own capital as dividend. Besides, the attraction of dividend often blinds their investment decisions and they end up investing in funds that do not actually merit an investment.

Here is an example of why it does not make sense to follow this strategy. First, if a fund declares 100 per cent dividend, it is paid on the face value, which is Rs 10 in most cases, and not on the NAV. Second, once the dividend is paid, the fund's NAV gets reduced by the dividend amount. For example, if the NAV of a fund paying 100 per cent dividend is Rs 40 on the record date, it will come down to Rs 30 post-dividend. Therefore, while an investment of Rs 10,000 will get an investor a dividend of Rs 2,500, its current value will also come down to Rs 7,500.

It is important to know that dividend payment by mutual funds is a process of distributing gains to its unit holders, and only those who remain in the fund for a considerable period benefit from it in the real sense.

Compromising long-term growth
Investors often lose sight of their long-term goals when they spot an opportunity to make some short-term gains. For example, in a market situation such as now, it can be tempting to either pull money out of equity funds or stop  investing in them and instead redirect funds to attractive debt options such as fixed maturity plans (FMP).

While this might look like a great investment decision now, investors will still have reinvestment risk to tackle when the FMPs mature.

A likely scenario of lower interest rates and improved indices levels might compel the same investors to re-enter the stock market at a higher level. Such strategies can affect the end result for a long-term investor.
 
Ignoring debt portfolio
It is quite common to see investors ignore their debt portfolio as they are considered to be safe. It is important for debt fund investors to know that bond prices move inversely to interest rates. When interest rates go up, bond prices go down and when interest rates go down, bond prices go up.

Since movements in interest rates can have a significant impact on a debt portfolio, there is a need to monitor it not only to realign it in line with the changing interest rate scenario but also to protect gains. 

Simply put, the key is to manage credit and duration risk efficiently. Among the debt funds, a major differentiator is the maturity duration of the portfolio. Each category of debt funds has a different risk profile and commensurate return potential. The longer the maturity duration of the portfolio, the greater is the impact of an interest rate change. As is evident, debt fund investors need to tread carefully and keep an eye on the emerging rate scenario.
 
The author is CEO of Wiseinvest Advisors

(This story was published in Businessworld Issue Dated 30-04-2012)